Auditing and Assurance Services: Key Audit Matters Analysis

This report provides an in-depth analysis of auditing and assurance services, focusing on the identification and communication of key audit matters (KAM). It examines two case studies, Advanced Computer Solutions and Green Machine Ltd, to illustrate the application of ASA 701 in determining and disclosing KAM. The analysis includes assessing audit assertions related to inventory and property, plant, and equipment (PPE), identifying risks of material misstatement, and developing substantive audit procedures. For Advanced Computer Solutions, the report addresses accuracy/valuation and cut-off assertions related to inventory, while for Green Machine Ltd, it focuses on accuracy and valuation assertions concerning PPE. The report details the rationale behind determining specific issues as KAM and provides a structured disclosure of these matters, including their significance and the audit procedures employed to address them. The report concludes by emphasizing the importance of effectively communicating KAM to enhance the transparency and reliability of financial reporting.

Running head: AUDITING AND ASSURANCE SERVICES
Auditing and Assurance Services
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Introduction................................................................................................................................2
Question 1: Advanced Computer Solutions...............................................................................2
Answer to [a]..........................................................................................................................2
Answer to [b]..........................................................................................................................3
Answer to [c]..........................................................................................................................4
ASA 701 Communicating the Key Audit Matters..............................................................4
Rationales for Determination.............................................................................................5
Disclosure of Key Audit Matters.......................................................................................5
Question 2: Green Machine Ltd.................................................................................................6
Answer to [a]..........................................................................................................................6
Answer to [b]..........................................................................................................................7
Answer to [c]..........................................................................................................................8
ASA 701 Communicating the Key Audit Matters..............................................................8
Rationales for Determination.............................................................................................9
Disclosure of Key Audit Matters.......................................................................................9
Conclusion................................................................................................................................10
References................................................................................................................................11
Introduction

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The prime responsibility of the auditors can be found in the examination as well as
analysis of the financial statements of the companies in order to ensure the fact that there is
not any material misstatements in them as a result of errors and frauds; and the key
stakeholders of the companies use the report of the auditors to verify the fairness and
truthfulness of the company’s financial statements (Bédard and Courteau 2015). At the time
of the development of these financial statements and reports, the managements of the audit
clients use certain assertions. Audit assertions are the implicit or explicit claims along with
certain representations that the managements of the clients make for the preparation of
financial statements concerning its appropriateness of various financial statements elements
and disclosures. Managements of the companies use different audit assertions for inventory,
property, plant and equipment and others; such as accuracy, valuation, cut off, completeness,
existence, occurrence and others (Knechel and Salterio 2016). At the time of auditing the
clients’ financial statements, it is essential for the auditors to consider examining these audit
assertions with the aim to verify the truthfulness of the used judgements and assumptions by
the managements for the preparation of financial statements. After that, they need to
determine the Key Audit Matters in case the risks have significance in auditing (Louwers et
al. 2015). This report sheds light on the used assertion of the given companies from the
perspective of an auditor for the determination of key audit matters.
Question 1: Advanced Computer Solutions
Answer to [a]
Accuracy/Valuation
At the time to test this audit assertion, the two significant matter faced by the auditors
are to provide the necessary assurance on the correctness of all the values and figures of
physical inventory count and to provide assurance on the aspect that correct amount of

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inventory has come as cost of goods sold in the income statements from the balance sheet
(Stagg et al. 2018). For these reasons, accuracy or valuation of inventory needs to be tested
by the auditors. The case study of Advanced Computer Solutions shows that the inventories
of the company are transferred to six new regional warehouses and this incident can lead to
the miscalculation in the physical inventory count which can reduce the inventory turnover in
2018. In addition, issues in software can cause error in the inventory valuation process (Ma
2016). These reasons states that this assertion is at risk.
Cut Off
It is needed for the managements of the audit clients to ensure proper recording of the
values of inventory in the correct accounting period when they take place. Considering
examination of the shipping and receiving documents of inventory is a crucial aspect as it
assists in cut off of inventory (Bumgarner and Vasarhelyi 2018). Hence, the companies
cannot record the value of inventory of past year in the accounting book of the present year.
However, this aspect can be seen in case of Advanced Computer Solution as the inventory of
the year 2018 consists of the sales of both 2018 and 2017. This event is the proof that there is
an error or errors in the recording of inventory in the correct year’s accounting books. It can
also be happened that the problem in software might lead to this issue or any staff is
responsible for the same (Kharisova and Kozlova 2014). Hence, it is evident that this
assertion is at risk.
Answer to [b]
Substantive Audit Procedure 1: For addressing this risk, the main audit procedure is the
methodical surveillance of every aspect of the physical inventory count procedure of
Advanced Computer Solutions (Glover, Prawitt and Drake 2014). Certain initiatives that the
auditor needs to take are conversing about the strengths and weaknesses of internal control

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related to inventory, verifying the tags made for the inventory count and to be present when
the inventory counts process is on progress. Moreover, the inventories need to be examines in
all the warehouses. Lastly, the auditor needs to test the judgments and assumptions of the
management along with their compliance with the required accounting standards (Glover,
Prawitt and Drake 2014).
Substantive Audit Procedure 2: For the examination of cut offs, the substantive audit
procedure will be the verification of all the notes for goods received and goods supplied so
that the reporting date can be identified (Byrnes et al. 2018). After that, the auditor needs to
undertake examining whether the inventory moved slowly or there was any irrational
adjustments in them. Moreover, the auditor need to verify whether the company has provided
any stop order in receiving the inventories in the warehouses as these aspects together can
create the issue of inventory cut offs (Byrnes et al. 2018).
Answer to [c]
ASA 701 Communicating the Key Audit Matters
As per Section 7 of ASA 701, the objectives of the auditors are the ascertainment of
the key audit matters, formulation of the key audit matters based on them and disclose as well
as communicate them in the auditor’s report (auasb.gov.au 2019).
According to the definition of Key Audit Matters in Section 8 of ASA 701, these are
the issues or matters that are important to the auditors to audit the financial reports of the
clients; and they need to be selected from the discussion with the governance team
(auasb.gov.au 2019).
According to Section 9 of ASA 701, the auditors are required to consider three
specific requirements in determining the key audit matters; they are the parts in the financial
statements with the higher risk of material misstatements in accordance with ASA 315, the

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judgements as well as accounting estimates used by the management of clients that are in
uncertainty and the impact of the significant transactions or issues on auditing that occurred
during the accounting period (auasb.gov.au 2019).
According to Section 10 of ASA 701, key audit matters need to be determined by the
auditors after the consideration of the significant events and their impact on auditing
(auasb.gov.au 2019).
Rationales for Determination
 The presence of errors in inventory valuation can be considered as significant area in
the financial statements having higher risk of material misstatements.
 The presence of errors in inventory valuation indicates that there may be some
uncertainties in the used judgments and accounting estimates used by the management
for the inventory valuation.
 The occurrence of significant events can be seen that is the transfer of inventories in
six different warehouses from the central warehouse that can have impact on the
process of inventory count and valuation (Kachelmeier, Schmidt and Valentine 2017).
Disclosure of Key Audit Matters
Why Significant How Audit Addressed the Key Audit
Mattes
Transfer of inventory on March 2018
The company has recently transferred their
huge inventory base from one central
warehouse to six different warehouses and
the physical inventory count process can be
impacted with this incident. In addition,
inventory valuation includes significant
judgment and accounting estimated of the
management that are significant for the audit.
The undertaken audit procedures are:
- Methodical surveillance of every aspect of
the physical inventory count procedure
- Conversing about the strengths and
weaknesses of internal control related to
inventory
- Verifying the tags made for the inventory
count
- Observe when the inventory counts process

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is on progress
- Test the judgments and assumptions of the
management along with their compliance
with the required accounting standards
-Testing the inventories in all warehouses
Inclusion of previous year’s sales in the
inventory of 2018
The inventory of 2018 consists of the sales of
2018 and 2017 that indicates the presence of
error. In addition, involvement of significant
management’s judgements and accounting
estimates are there. These can have material
impacts.
The undertaken audit procedures are:
- Verification of all the notes for goods
received and goods supplied so that the
reporting date can be identified
- Examining whether the inventory moved
slowly or there was any irrational
adjustments in them
- Verify whether the company has provided
any stop order in receiving the inventories in
the warehouses
Question 2: Green Machine Ltd
Answer to [a]
Accuracy: The use of this particular assertion demands the commitment of the companies to
accurately record all the transactions related to property, plant and equipment. It means the
companies need to ensure the appropriate classification and distinction of all the expenses
related to the property, plant and equipment (Peytcheva 2013). The case study of Green
Machine Ltd shows the inaccurate distinction of the revenue and capital expenditures by the
company. Certain revenue expenses are capitalized and certain capital expenditures are
showed as revenue expenses in the income statements. Thus, it is clear from this aspect that
there is error in the classification of major expenses related to property, plant and equipment
in the company which can create material effects on the company’s financial statements
(Omer, Sharp and Wang 2018). For this reason, this assertion is at risk.

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Valuation: This particular assertion demands the commitment of the audit clients that they
will record all the assets, liabilities and equity at their cost value after the deduction of
accumulated depreciation; and thus, they must apply the correct rate of depreciation. This is
an essential requirement for the companies (Mock and Fukukawa 2015). As per the case
study of Green Machine Ltd, the rates of depreciation charged on property, plant and
equipment are too low and this aspect can lead to the incorrect valuation of property, plant
and equipment. Apart from this, application of the low depreciation rate can create different
in operating expenses of the company which can ultimately leads to the misstatements of
company’s net profit. In the presence of all these reasons, this assertion can be considered at
risk (Bowlin, Hobson and Piercey 2015).
Answer to [b]
Substantive Audit Procedure 1: In the part of substantive audit procedures, the auditor of
Green Machine Ltd must review the policies and procedures of the company for the
determination of the capital and revenue expenditures related to property, plant and
equipment (Kuenkaikaew and Vasarhelyi 2013). In order to do this, it is needed for the
auditor to collect the list of property, plant and equipment and must ensure verifying the fact
that the company has complied with the necessary accounting regulation and standards
related to the expense of property, plant and equipment (Kuenkaikaew and Vasarhelyi 2013).
Substantive Audit Procedure 2: In this part of the substantive audit procedure, it is essential
for the auditor of the company to review the deprecation policies of the company along with
reviewing the judgments and accounting estimated used by the management (Pizzini, Lin and
Ziegenfuss 2014). After that, the auditor needs to consider recalculating the rate of
depreciation after analyzing the property, plant and equipment’s residual value and any gain
or loss from the sale of them. In this process, comparison of the ratios of depreciation needs

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to be done. In this process, the auditor will be able to recalculate the revised rates of
depreciation along with the revised depreciation expenses (Pizzini, Lin and Ziegenfuss 2014).
Answer to [c]
ASA 701 Communicating the Key Audit Matters
According to Section 7 of ASA 701, the auditor’s objectives are the determination of
the key audit matters, development of appropriate audit opinion based on them and reveal as
well as converse them in the report of the auditor (legislation.gov.au 2019).
As per the description of Key Audit Matters in Section 8 of ASA 701, they are the
issues or substances that are significant to the auditors to audit the financial reports of the
clients; and they need to be selected from the conversation with the governance authorities of
the companies (legislation.gov.au 2019).
As per Section 9 of ASA 701, the auditors must take into account three specific
requirements for the determination of the key audit matters; they are the regions in the
financial statements with the superior risk of material misstatements according to the
standards of ASA 315, the judgements and accounting estimates utilized by the management
of clients that are in doubt and the impact of the significant transactions or issues on auditing
that took place during the accounting period (legislation.gov.au 2019).
According to Section 10 of ASA 701, the auditors are needed to determine the key
audit matters after taking into account the significant events and their impact on auditing
(legislation.gov.au 2019).
Rationales for Determination
 The inappropriateness in the distinction of capital and revenue expenses along with
the incorrect valuation of depreciation are the areas in the financial statements of
Green Machine Ltd containing greater material misstatements risks.

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 The involvement of the management’s significant judgements and accounting
estimates can be seen in these areas that are not certain as doubts are there in them
(Simnett and Huggins 2014).
 There are two significant transactions and errors; they are the wring division of
expenses and application of low depreciation rates that have significant impact on the
company’s audit.
Disclosure of Key Audit Matters
Why Significant How Audit Addressed the Key Audit
Mattes
Incorrect distinction between the capital
and revenue expenditures
The company has done wrong distinction
between the capital and revenue expense that
can create material effects on the financial
statements and it involves judgement and
accounting estimates of the management
which are crucial for the auditing.
The undertaken audit procedures are:
- Review the policies and procedures of the
company for the determination of the capital
and revenue expenditures related to property,
plant and equipment
- Collect the list of property, plant and
equipment for verification
- Ensure verifying the fact that the company
has complied with the necessary accounting
regulation and standards
Appliance of Low Depreciation Rates for
Property, Plant and Equipment
Low rate of depreciations have been applied
in property, plant and equipment that can
create material impact on the company’s
financial statements. In addition, the
management has used certain accounting
estimates and judgments which are important
for the audit of the company.
The undertaken audit procedures are:
- Review the deprecation policies of the
company - Reviewing the judgments and
accounting estimated used by the
management
- Recalculating the rate of depreciation after
analyzing the property, plant and
equipment’s residual value and any gain or
loss from the sale of them

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Conclusion
It can be seen from the above discussion that the key assertions at risk for Advanced
Computer Solutions are accuracy/valuation and cut off; and the key assertions at risk for
Green Machine Ltd are accuracy and valuation. It can be seen from the discussion part of the
report that the auditors are needed to take into account the assertions at risk at the time to plan
the substantive audit procedures as these procedures must be able to minimize the risks. ASA
701 provides the auditors with the necessary guidelines and principles for the determination
of the key audit matters. The above discussion shows the responsibility of both the auditors of
the companies to effectively communicate and disclose the key audit matters in the respective
section of the audit report. Hence, it is the obligation on the auditors to adhere to the
standards of ASA 701 for determining the key audit matters.

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References
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2019].
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professional skepticism, and interactions with managers on audit quality. The Accounting
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Kachelmeier, S.J., Schmidt, J.J. and Valentine, K., 2017. The disclaimer effect of disclosing
critical audit matters in the auditor’s report.